Debt check-up: Are you at risk if interest rates rise?

Interest rates are at all-time lows in Canada, but they are likely to rise at some point. When they do, you can expect that your debt payments will increase if:

you have a mortgage, a line of credit or other loans with variable interest rates

you are nearing the end of the term on a fixed interest-rate mortgage or loan and will need to renew it.

Have you risk-proofed your budget to ensure you can manage future increases in your debt payments? If you are already close to the maximum payments you can afford, it’s time to think about how you can prepare to manage your debt if interest rates and your payments increase

Example: Impact of interest rate increases

Sofia and Lucas bought their first home for $320,000 in 2010.1 They had a $32,000 down payment (10%), so they needed mortgage default insurance, which brought their mortgage loan to $294,912. They chose a variable interest-rate mortgage for a five-year term, with a 25-year amortization period. They also have other debts, as shown below.

They have been making all their payments, but they have trouble putting aside money for savings. They are starting to worry about what would happen if interest rates on their mortgage and some of their other debts increase. They decide to check how interest rate increases of 0.5%, 1%, 2% and 3% would affect them.

Mortgage

After two years, the outstanding balance on Sofia and Lucas’ mortgage is now $278,748, with 23 years remaining on the amortization period. The variable interest rate is currently set at 3.1%.2 Their current monthly mortgage payment is $1,411.

Car loan

The current balance is $10,000, with three years remaining on the term. The interest rate is fixed at 5.5%,2 and monthly payments are $302.

Personal loan

Lucas has a personal loan of $6,000 to be paid off in two years, with a variable interest rate currently set at 4.75%2 and a monthly payment of $262.

Credit card debt

The couple is carrying $6,500 in credit card debt, with an interest rate of 19.9%.2 They aim to pay it off within two years by making monthly payments of $328. (This assumes that they do not add any new charges to the credit card during that time, and that the interest rate stays the same.)

Description​

Balance​

Current interestrate​

Amortizationor repayment period​

Current monthly payment​

Monthly paymentif interest rateincreases:

+ 0.5%

+ 1%

+ 2%

+ 3%

Mortgage costs​ ​ ​ ​ ​ ​

Mortgage​

$278,748​

3.1%​

23 years​

$1,411​

$1,483​

$1,556​

$1,709​

$1,868​

​Debts with variable interest rates​

Personal

loan,

variable

rate​

$6,000​

4.75%​

2 years​

$262​

$264​

$265​

$268​

$270​

​

​Other debt payments:fixed interest rate or unlikely to be affected by 0.5%–3% increase​

Car loan​

$10,000​

5.5%​

3 years​

$302​

$302

$302​

$302​

$302​

​

Credit

card​

$6,500​

19.9%​

Target

repayment

in 2 years​

$328

$328​

$328​

$328​

$328​

​

Total

monthly

debt

payments​

​

​

​

$2,303​

$2,377​

$2,451​

$2,607

$2,768​

​

Increase

in monthly

costs​

​

​

​

---- ​

$74​

$148​

$304​

$465​

​

Sofia and Lucas were surprised to see that if interest rates increase by 1%, they will have to find almost $150 in their monthly budget to cover the higher costs. If rates rise by 3%, their monthly payments will be over $450 higher.

Sofia and Lucas decide that they are outside their financial comfort zone. They consider options to have more money available to repay debts and save for their goals.

Tips

If you have debts with high interest rates, such as credit cards, consider consolidating your debts in a loan with a lower rate, BUT

keep your payments the same, and

avoid taking on any more debt.

This will help you reduce your debt levels faster, since more of your payment will go toward the principal.

Paying off your debt with the highest interest rate first will reduce the amount you are paying in interest and help you reduce your debts more quickly.

If you are considering borrowing more, take a close look at how it would impact your payments, your budget and your ability to save for other goals. Stay within your comfort zone.

You are in the danger zone if:

you are already having trouble making your debt payments, or

you are close to your limit and would have trouble making higher payments if interest rates increase.

To reduce your risk, review your budget with a goal of reducing your spending, so that you have more money available to repay debts.

Remember that getting the biggest mortgage or line of credit that you are offered may push your financial limits. Leaving some room to deal with the unexpected will reduce the stress on your finances—and your nerves.